A blog on strategies, and applying strategic perspectives on business related issues, and on miscellaneous discussions about China

2005-06-13

RMB according to bigmac index

The Economist has been using the Bigmac Index as a reference point for comparing currency exchange rates. They claim that it has been working pretty well, ridding the drawback of the official forex rate which does not reflect purchasing parity (PPP) while compensating the PPP definition by including local cost factors such as labor and rent. Most important of all, bigmac (as claimed) has the "exact" quality across the world, and therefore can be looked at like a commodity item for price comparison, while retaining various valuation factors of social production cost elements (such as labor, rent, etc.).

It can be seen that there has been less than 10% change in the bigmac exchange rate from 1997 to 2005. If, as widely believed at the time, RMB was over-valuated in 1998 after the Asian financial crisis, how can one argue that RMB is under-valuated today? Even if one assumes that the valuation was fair in 1997/1998, RMB was only undervaluated by 10% (=59/54-1) today. The bigmac rate might be inaccurate, but it is a good indicator for longitudinal comparison for the same currency. (e.g. price will usually be adjusted if there is an overshooting correction in the exchange rate such as that in SE Asia and S America)

One may argue that RMB has been under-valued all the time (by 50%+), then why is China the only target chosen for 'currency manipulation' accusation? Based on the 2005 table, many countries has similar "under-valuation" as China's. e.g. Indonesia (-50), Philippines (-50), Thailaind (-52), Hundura (-38), Paraguay (-53), Argentina (-46), Qatar (-78), Russia (-52), Ukraine (-53), Egypt (-49), etc. Selective discrimination in trading is not allowed in WTO, I thought. What about Oman (+109), Iceland (+118), Kuwait (+142), Switzertland (+65), Denmark (+50)? Should they be suing US (and everybody else in the world) for currency manipulation? To be fair, yes, RMB is definitely undervalued, but it was just as undervalued as it was in 1997/98 when there was a huge pressure for DEVALUATION. Nothing much has changed in terms of trade or economic balance in the world since then. What has changed between these years are (1) the weight of China trade in the world equation has increased (2) the productivity and product quality in China has increased, and (3) product category widen. A change in exchange rate does not change these economic fundamentals. In other words, changing the RMB exchange rate by, say 10%, is not likely to change the world's trading flow much.

Maybe it is Uncle McDonald's fault? Should Uncle McDonald be sued for dumping in China, Qatar and Ukraine? It is hard to imagine McDonald's, as a business operation which prices its products rationally, is giving away bigmacs in China. So I should probably accept that McDonald's is pricing competitively and reasonably, and therefore, the bigmac index reflects a rational business decision of a major profitable international corporation. Then if McDonald's is not complaining about currency manipulation and Ukraine is not complaining about McDonlad's dumping, perhaps there isn't much we should do to change the RMB peg?